For Chinese exporters, the grass is greener abroad

The U.S.-China tyre dispute threatens to spill into other sectors and further squeeze Chinese exporters’ already razor-thin margins. It might seem mind-boggling to many that Chinese manufacturers are still hanging on to weak overseas markets even though the domestic economy looks much healthier and surely offers more potential.

But there are structural reasons why the grass is greener outside China. The risk of not getting paid, or getting paid late, is significantly lower when dealing with foreign buyers. The cost of international shipping has dropped so much that it can be cheaper to send goods over the Pacific Ocean than across the country.

In addition, selling to large buyers such as Wal-Mart creates enough volumes to compensate for weak margins. Moreover, Chinese exporters get all sorts of export rebates and local government incentives which help to lower their costs.

But as the tyre spat has illustrated, Washington can slap punitive duties on Chinese imports simply by pointing to a significant increase in imports from China. By imposing penalties in this case, President Obama has opened the door for a slew of similar complaints against Chinese goods. It will only be a matter of time before other countries, worried about where those displaced Chinese exports might end up, start to follow suit.

That’s why Chinese policy makers need to get more serious about stimulating domestic spending. It is time for Beijing to revamp a system built over the past three decades that explicitly and implicitly favours exports and to encourage manufacturers to prioritise selling to the domestic market .

A good first step would be to reduce some of the export incentives China offers to certain industries. These effectively subsidise foreign consumers at the expense of domestic customers. For example, Chinese tyre-makers get about 9 percent tax rebate on the value of the products they sell abroad. That’s why tyre makers can afford to price exported tyres more cheaply than the ones sold at home, according to Xu Qiyuan, a researcher at China’s Social Science Academy.

To date, however, China’s response to the credit crunch has been to boost incentives to prop up export markets. Beijing raised export rebates on 3,802 items from April 1. Textile exporters also got an increase in their rebate to 16 percent from 15 percent. This activity is not illegitimate and many countries subsidise exports. But the US enforcement action shows that this policy may have practical limits.

China needs more than just a change of heart on subsidies. Longer term Beijing needs to foster the development of a healthy credit culture for suppliers so they can get paid on time, and improve China’s transportation infrastructure in order to reduce the cost of moving goods around the country , and most importantly, break down local protectionism that discriminates against suppliers from other provinces. It may seem odd but China still needs to create a single internal market.

Despite all the talk about Chinese consumers unwilling to spend because of a lack of a social safety net, one important reason that they don’t buy much at home is because prices are often too high. When “frugal” Chinese consumers go to Hong Kong or London, they immediately become big spenders, splashing out thousands of dollars on clothing, cosmetics, bags and watches. The irony is that a lot of the things they buy are actually made in China, but are simply not available there, or cost much more.

Moreover the lack of a single market hampers foreign companies seeking to sell to China. Although foreign executives might fancy China as a giant market with 1.3 billion customers, the reality is that it is extremely fragmented, so economies of scale are hard to achieve. Transporting goods from one province to another can incur hefty tolls levied by local governments which want to drum up local revenue and make it harder for companies to break into their local markets.

The credit problem also needs to be addressed. Big Chinese retailers only pay for goods on delivery. An exporter, by contrast, gets a letter of credit when the order is placed, and this can be cashed in to finance production.

China’s rebalancing away from export dependence has barely begun, and it will take a long time to change attitudes. But now would be a good time to make a start. The recent trade disputes over Chinese tyres and toys should serve as warning shots. China’s leaders must start the domestic market more friendly to suppliers and consumers.